[PapaBear3625]

This isn’t a real problem as settlement may be made in cash.

Oh there is INDEED a real problem.

I incorporate PapaBear Inc and issue 1000 shares, which palmer buys and holds. You naked sell 1000 shares to Toddsterpatriot. You then sell another thousand shares to freeandfreezing. There are now 3,000 shares in circulation of a company which only has 1000 shares. You start seeing the problem?

[Warlord]

You describe a synthetic sale of equity. A synthetic sale of 2000 PapaBear Inc. equity shares does not result in an additional 2000 equity shares in PapaBear issued and outstanding. It's just a contract the value of which is a function of the price of PapaBear equity which may be settled physically or cash with a notional of 2000 equity shares. Under the contract that you describe, the only problems are (i) the credit risk presented to counterparties if the share price goes up or (ii) the credit risk present to me if the share price goes down. The moral to the story is that settlement may always be made in cash and that the only problem is counterparty credit risk. I thing the flaw in your argument is that you confuse notional with actual. The notional in a derivative is nothing more than a value against which payoffs are determined.